In this article, three oft‐mentioned special characteristics of the real estate asset market—high transaction costs, marketing period risk and return predictability—are addressed in analyzing the role of U.K. commercial real estate investments in a mixed‐asset portfolio. Due to favorable horizon effects in risk and return, the allocation to real estate in a portfolio with stocks, bonds and cash increases strongly with the investment horizon. Examining the relative importance of return predictability, transaction costs and marketing period risk for the optimal allocation to real estate, the article finds that the consideration of return predictability is very important, except for short‐term horizons. Accounting for transaction costs is crucial for short‐ and medium‐term investors. Marketing period risk appears to be negligible. Traditional mean‐variance analysis—that is, ignoring return predictability, transaction costs and marketing period risk—can be very misleading.

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Focusing on the role of the investment horizon, we analyze the inflation-hedging abilities of stocks, bonds, cash and direct commercial real estate investments. Based on vector autoregressions for the UK market we find that the inflation-hedging abilities of all assets improve with the investment horizon. For long horizons, real estate seems to hedge unexpected inflation as well as cash. This has implications for the difference between the return volatility of real returns versus the return volatility of nominal returns, and ultimately for portfolio choice. Portfolio optimizations based on real returns yield higher allocations to cash and real estate than optimizations based on nominal returns. Bonds tend to be less attractive for an investor taking into account inflation. Switching from nominal to real returns, the allocation to stocks is decreasing at medium investment horizon, but increasing at long horizons.

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